Quantitative Easing Pt. 3: Return of the Jedi (or Revenge of the Sith depending on how you look at it)

The summer has barely begun, yet it’s already clear that the US economy will be a hot topic.

To stimulate a weakening enterprise, an old standby may be brought out yet again. No, not Billy Crystal. But Quantitative Easing.

If Bernanke announces in the June 19-20, 2012 Federal Open Market Committee (FOMC) meeting that another round of Quantitative Easing is a go, you have to wonder this: will this third round be an optimistic tale of the defeat of downward market “forces”, or a dark tale about succumbing to the force?

Hopefully, it’ll be an optimistic sequel. Because unless you’re the producer of the Matrix trilogy, why would you try something again unless the previous versions made complete sense?

What is Quantitative Easing?

Quantitative Easing, in a nutshell, involves the Fed printing new money and purchasing primarily bond (e.g., fixed-income) securities from banks and other related businesses in order to provide those institutions with excess reserves that can be lent to consumers.

This artificial demand for bonds (including mortgaged-backed securities and treasuries) also drives up bond prices, which in turn forces the interest rates of existing bonds to decline since bond prices and interest rates are inversely related. As a result, the loan that a lucky consumer is able to get will ideally have a lower interest rate after quantitative easing. Which means more money in that person’s’ pockets to spend, not only from the loan itself but also from the lower interest rate on their loan.

In other words: a QE program begins, then magic happens, and then we have increased economic activity and (ideally) more jobs since consumers are spending more money at businesses.

Did QE 1 and QE 2 Work?

It depends on how you look at it.

From the interest rates/monetary policy point of view:

QE 1 worked, but QE 2…eh, not so much but not a failure either. Rates dropped significantly after the QE 1 bond-buying program started in Nov 2008, and continued to drop after the QE 1 bond-buying program ended in March 2010. And while rates spiked at the beginning of QE 2 in Nov 2010, rates fell by the time QE 2 ended at the end of June 2011 and continued to fall thereafter.

From the Main Street/My Wallet/My Job point of view:

While QE 1 occurred, the employment continued to fall. However when QE 1 ended (and whether this is causal is still a debate), employment rose despite the fact that loans to consumers were falling.

During QE 2, the net change in employment continued to rise, but didn’t stick and fell during and after the program ended.

Data Sources: US Bureau of Labor Statistics and Federal Reserve Board of Governors

The conclusion here is that there’s not a heck of a lot of correlation between consumer loans and economic activity/employment (which makes sense because anyone who got a loan likely used it to pay off bills and not to buy cars and homes, which stimulates economic activity and ideally jobs). So why is QE 3 being discussed with people as an economic/employment stimulus tool when the cause and effect relationship doesn’t appear to be there? Bernanke?

Will QE 3 Happen?

Noone’s arguing that righting the US economic ship is difficult and complex, and 2008 was unlike anything our country has ever seen. But these rounds of QE have turned into more of a PR attempt to boost consumer confidence instead of a policy that provides tangible results for the citizens that do the hiring in our government.

Let’s see how this story ends. Or goes on, and on again, until the force either cries uncle or asks “who’s your daddy?”.

The information does not constitute investment advice or an offer to invest or to provide management services and is subject to correction, completion and amendment without notice. Any such offer, if made, will only be made by means of a confidential prospectus or offering memorandum or management agreement. It it not our intention to state, indicate or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Prior to making any investment, a prospective investor should consult with its own investment, accounting, legal and tax advisers to evaluate independently the risks, consequences and suitability of that investment.

About The Wall Street Geek

After turning $1100 into $7015 in the stock market right out of college, the author of "The Wall Street Geek" worked for 15 years on Wall Street. In this investment blog, she gives investment tips and insights to help everyday investors be successful. Read More >>

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